Why is core inflation is lower than the CPI

Answer 1

Core inflation measures the overall change in prices for all goods and services in an economy, excluding the prices of highly volatile items such as food and energy. On the other hand, the Consumer Price Index (CPI) measures the average change in prices that consumers pay for a basket of goods and services, including food and energy.

There are several reasons why core inflation tends to be lower than the CPI:

1. Exclusion of highly volatile items: Core inflation excludes the prices of food and energy, which are prone to significant fluctuations due to factors like weather conditions, geopolitical tensions, and changes in global oil prices. These items can have sharp price swings in the short term, which can inflate the CPI. By excluding them, core inflation provides a more stable and long-term view of price changes.

2. Policy focus: Central banks often use core inflation as the main indicator for setting monetary policy. They aim to maintain price stability and avoid sudden inflationary shocks or deflationary pressures. Core inflation provides a more reliable signal for underlying inflation trends, as it eliminates the noise caused by volatile items.

3. Methodology differences: The calculation methods for core inflation and the CPI differ slightly. Core inflation focuses on a subset of goods and services, while the CPI covers a broader basket of items. The weighting and frequency of data collection may also vary, leading to small disparities in the final figures.

It's important to note that while core inflation may be lower than the CPI, both indicators serve different purposes and are useful for different analyses. The CPI provides a more comprehensive view of consumer price changes, while core inflation offers a clearer picture of underlying inflation trends.